INTERNATIONAL
FINANCIAL
MANAGEMENT
Fourth Edition
EUN / RESNICK
3-0
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
The Balance
of Payments
Chapter Objective:
3
Chapter Three
INTERNATIONAL
FINANCIAL
MANAGEMENT
This chapter serves to introduce the student to the
balance of payments. How it is constructed and
Fourth Edition
how balance of payments data may be interpreted.
EUN / RESNICK
3-1
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter Three Outline


Balance of Payments Accounting
Balance of Payments Accounts






3-2
The Current Account
The Capital Account
Statistical Discrepancy
Official Reserves Account
The Balance of Payments Identity
Balance of Payments Trends in Major
Countries
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Balance of Payments Accounting

The Balance of Payments is the statistical record
of a country’s international transactions over a
certain period of time presented in the form of
double-entry bookkeeping.
N.B. when we say “a country’s balance of
payments” we are referring to the transactions of
its citizens and government.
3-3
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Balance of Payments Example



3-4
Suppose that Maplewood Bicycle in
Maplewood, Missouri, USA imports
$100,000 worth of bicycle frames from
Mercian Bicycles in Darby England.
There will exist a $100,000 credit recorded
by Mercian that offsets a $100,000 debit at
Maplewood’s bank account.
This will lead to a rise in the supply of
dollars and the demand for British pounds.
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Balance of Payments Accounts


The balance of payments accounts are those that
record all transactions between the residents of a
country and residents of all foreign nations.
They are composed of the following:




3-5
The Current Account
The Capital Account
The Official Reserves Account
Statistical Discrepancy
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
The Current Account




Includes all imports and exports of goods and
services.
Includes unilateral transfers of foreign aid.
If the debits exceed the credits, then a country is
running a trade deficit.
If the credits exceed the debits, then a country is
running a trade surplus.
3-6
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
The Capital Account



The capital account measures the difference
between U.S. sales of assets to foreigners and U.S.
purchases of foreign assets.
In 2004, the U.S. enjoyed a $611.2 billion capital
account surplus—absent of U.S. borrowing from
foreigners, this “finances” our trade deficit.
The capital account is composed of Foreign Direct
Investment (FDI), portfolio investments and other
investments.
3-7
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Statistical Discrepancy


There’s going to be some omissions and
misrecorded transactions—so we use a “plug”
figure to get things to balance.
Exhibit 3.1 shows a discrepancy of $51.9 billion
in 2004.
3-8
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
The Official Reserves Account

Official reserves assets include gold, foreign
currencies, SDRs, reserve positions in the IMF.
3-9
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
The Balance of Payments Identity
BCA + BKA + BRA = 0
where
BCA = balance on current account
BKA = balance on capital account
BRA = balance on the reserves account
Under a pure flexible exchange rate regime,
BCA + BKA = 0
3-10
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
U.S. Balance of Payments Data
Credits
Debits
Current Account
1
Exports
2
Imports
3
$1,516.2
($2,109.1)
Unilateral Transfers
Balance on Current Account
Capital Account
4
5
6
Direct Investment
Portfolio Investment
Other Investments
Balance on Capital Account
7
Statistical Discrepancies
Overall Balance
Official Reserve Account
3-11
$16.4
($89.4)
($665.9)
$115.5
$794.4
$524.3
$611.2
51.9
$2.8
($248.5)
($90.8)
($483.7)
$2.8
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
U.S. Balance of Payments Data
Credits
Debits
Current Account
1
Exports
2
Imports
3
$1,516.2
($2,109.1)
Unilateral Transfers
Balance on Current Account
Capital Account
4
5
6
Direct Investment
Portfolio Investment
Other Investments
Balance on Capital Account
7
Statistical Discrepancies
Overall Balance
Official Reserve Account
3-12
$16.4
($89.4)
($665.9)
$115.5
$794.4
$524.3
$611.2
51.9
$2.8
($248.5)
($90.8)
($483.7)
In 2004, the
U.S. imported
more than it
exported, thus
running a
current account
deficit of
$665.9 billion.
$2.8
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
U.S. Balance of Payments Data
Credits
Debits
Current Account
1
Exports
2
Imports
3
$1,516.2
($2,109.1)
Unilateral Transfers
Balance on Current Account
Capital Account
4
5
6
Direct Investment
Portfolio Investment
Other Investments
Balance on Capital Account
7
Statistical Discrepancies
Overall Balance
Official Reserve Account
3-13
$16.4
($89.4)
($665.9)
$115.5
$794.4
$524.3
$611.2
51.9
$2.8
($248.5)
($90.8)
($483.7)
$2.8
During the same
year, the U.S.
attracted net
investment of
$611.2 billion—
clearly the rest
of the world
found the U.S.
to be a good
place to invest.
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
U.S. Balance of Payments Data
Credits
Debits
Current Account
1
Exports
2
Imports
3
$1,516.2
($2,109.1)
Unilateral Transfers
Balance on Current Account
Capital Account
4
5
6
Direct Investment
Portfolio Investment
Other Investments
Balance on Capital Account
7
Statistical Discrepancies
Overall Balance
Official Reserve Account
3-14
$16.4
($89.4)
($665.9)
$115.5
$794.4
$524.3
$611.2
51.9
$2.8
($248.5)
($90.8)
($483.7)
Under a pure
flexible
exchange rate
regime, these
numbers would
balance each
other out.
$2.8
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
U.S. Balance of Payments Data
Credits
Debits
Current Account
1
Exports
2
Imports
3
$1,516.2
($2,109.1)
Unilateral Transfers
Balance on Current Account
Capital Account
4
5
6
Direct Investment
Portfolio Investment
Other Investments
Balance on Capital Account
7
Statistical Discrepancies
Overall Balance
Official Reserve Account
3-15
$16.4
($89.4)
($665.9)
$115.5
$794.4
$524.3
$611.2
51.9
$2.8
($248.5)
($90.8)
($483.7)
In the real
world, there
is a statistical
discrepancy.
$2.8
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
U.S. Balance of Payments Data
Credits
Debits
Current Account
1
Exports
2
Imports
3
$1,516.2
($2,109.1)
Unilateral Transfers
Balance on Current Account
Capital Account
4
5
6
Direct Investment
Portfolio Investment
Other Investments
Balance on Capital Account
7
Statistical Discrepancies
Overall Balance
Official Reserve Account
$16.4
($89.4)
($665.9)
$115.5
$794.4
$524.3
$611.2
51.9
$2.8
($248.5)
($90.8)
($483.7)
Including that,
the balance of
payments identity
should hold:
BCA + BKA = – BRA
$2.8
($665.9) + $611.2 + $51.9 = ($2.8)
3-16
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Balance of Payments and the
Exchange Rate
Credits
Debits
Exchange rate $
Current Account
1
Exports
2
Imports
3
Direct Investment
Portfolio Investment
Other Investments
Balance on Capital Account
7
Statistical Discrepancies
Overall Balance
Official Reserve Account
3-17
S
($2,109.1)
Unilateral Transfers
Balance on Current Account
Capital Account
4
5
6
P
$1,516.2
$16.4
($89.4)
($665.9)
$115.5
$794.4
$524.3
$611.2
51.9
$2.8
($248.5)
($90.8)
($483.7)
D
Q
$2.8
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Balance of Payments and the
Exchange Rate
Credits
Debits
Exchange rate $
Current Account
1
Exports
2
Imports
3
Direct Investment
Portfolio Investment
Other Investments
Balance on Capital Account
7
Statistical Discrepancies
Overall Balance
Official Reserve Account
S
($2,109.1)
Unilateral Transfers
Balance on Current Account
Capital Account
4
5
6
P
$1,516.2
$16.4
($89.4)
($665.9)
$115.5
$794.4
$524.3
$611.2
51.9
$2.8
($248.5)
($90.8)
($483.7)
D
Q
$2.8
As U.S. citizens import, they are supply dollars to the FOREX market.
3-18
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Balance of Payments and the
Exchange Rate
Credits
Debits
Exchange rate $
Current Account
1
Exports
2
Imports
3
Direct Investment
Portfolio Investment
Other Investments
Balance on Capital Account
7
Statistical Discrepancies
Overall Balance
Official Reserve Account
S
($2,109.1)
Unilateral Transfers
Balance on Current Account
Capital Account
4
5
6
P
$1,516.2
$16.4
($89.4)
($665.9)
$115.5
$794.4
$524.3
$611.2
51.9
$2.8
($248.5)
($90.8)
($483.7)
D
Q
$2.8
As U.S. citizens export, others demand dollars at the FOREX market.
3-19
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Balance of Payments and the
Exchange Rate
Credits
Debits
Exchange rate $
Current Account
1
Exports
2
Imports
3
($2,109.1)
Unilateral Transfers
Balance on Current Account
Capital Account
4
5
6
Direct Investment
Portfolio Investment
Other Investments
Balance on Capital Account
7
Statistical Discrepancies
Overall Balance
Official Reserve Account
P
$1,516.2
$16.4
($89.4)
($665.9)
$115.5
$794.4
$524.3
$611.2
51.9
$2.8
($248.5)
($90.8)
($483.7)
S
S1
D
Q
$2.8
As the U.S. government sells dollars, the supply of dollars increases.
3-20
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Balance of Payments Trends


Since 1982 the U.S. has experienced continuous
deficits on the current account and continuous
surpluses on the capital account.
During the same period, Japan has experienced the
opposite.
3-21
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Balances on the Current (BCA) and Capital
(BKA) Accounts of the United States
U.S. Balance of Payments Trend: 1982-2004
600
400
200
U.S. BCA
0
-200
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
Balance of Payments ($B)
800
U.S. BKA
-400
-600
-800
Year
Source: IMF International Financial Statistics Yearbook, various issues
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
3-22
Balances on the Current (BCA) and Capital
(BKA) Accounts of United Kingdom
40
30
20
10
0
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
-10
UK BCA
UK BKA
-20
-30
-40
-50
Source: IMF International Financial Statistics Yearbook, various issues
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
3-23
Balances on the Current (BCA) and Capital
(BKA) Accounts of Japan
150
100
50
Japan BCA
2004
2002
2000
1998
1996
1994
1992
1990
1988
1986
1984
-50
1982
0
Japan BKA
-100
-150
Source: IMF International Financial Statistics Yearbook, various issues
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
3-24
Balances on the Current (BCA) and Capital
(BKA) Accounts of Germany
80
60
40
20
0
2004
2002
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
-20
Germany BCA
Germany BKA
-40
-60
-80
-100
Source: IMF International Financial Statistics Yearbook, various issues
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
3-25
Balances on the Current (BCA) and Capital
(BKA) Accounts of China
60
50
40
30
China BCA
20
China BKA
10
2004
2002
2000
1998
1996
1994
1992
1990
1988
1986
1984
-10
1982
0
-20
Source: IMF International Financial Statistics Yearbook, various issues
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
3-26
Balance of Payments Trends

Germany traditionally had current account
surpluses.




From 1991 to 2001Germany experienced current
account deficits.
This was largely due to German reunification and the
resultant need to absorb more output domestically to
rebuild the former East Germany.
Since 2001 Germany returned to its earlier pattern.
What matters is the nature and causes of the
disequilibrium.
3-27
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Balances on the Current (BCA) and Capital
(BKA) Accounts of Five Major Countries
800
China BCA
600
China BKA
Japan BCA
400
Japan BKA
200
0
1980
-200
-400
Germany BCA
Germany BKA
1985
1990
1995
2000
2005
UK BCA
UK BKA
U.S. BCA
U.S. BKA
-600
Source: IMF International Financial Statistics Yearbook, 2000
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
3-28
Balance of Payment and
National Income
Chapter Three Appendix
Accounting
Sources of the U.S. Trade Deficit
3A
Chapter Objectives:
Introduction to the mathematical expression between
balance-of-payments and National Income
Accounting.
Investigate causes behind continuous U.S. trade
deficits and possible solutions to correct the trade
imbalance between U.S. and its trade partners.
3-29
Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved.
Balance-of-Payments and National Income
Accounting


GNP: Total value of all final goods and services
produced and sold in the markets.
National Income Identity


3-30
GNP ≡ C+I+G+(X-M)
Where C: Consumption, I: Investment, G: Government
Spending, X: Exports of Goods and Services, M:
Imports of Goods and Services
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Import and Export



C+I+G is the total use of goods and services in a
country,
If X-M <0, then GNP<C+I+G, i.e., the country
consumes and invests more than it produces..
If X-M>0 , then GNP>C+I+G, i.e., the country
consumes and invests less than it produces.
3-31
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Sources of Trade Deficit



Notice that savings S ≡ GNP-C-T, where T is
Taxes, so S=C+I+G+X-M-C-T
Then (S-I)+(T-G)=X-M≡BCA
CA deficit can be caused by low savings, excess
investment or government spending.
3-32
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Possible Sources








Excess Consumption
Excess Investment
Excess Government Spending
Low Savings
Strong Dollars
Attractive Financial Markets and Investment
Environment
Foreign Countries’ Unfair Trade Practices
Uncompetitive US Business
3-33
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Excess Consumption
Consumption as Percentage of GDP
72.00%
70.00%
68.00%
66.00%
64.00%
62.00%
60.00%
58.00%
19
80
19
81
19
82
19
83
19
84
19
85
19
86
19
87
19
88
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
56.00%
Year
3-34
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Government Spending
Government consumption expenditures and gross investment
2500
2000
1500
1000
500
19
80
19
81
19
82
19
83
19
84
19
85
19
86
19
87
19
88
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
0
Year
3-35
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Government Spending
Federal Deficit (Cumulative=$4.4 Trillion)
300
200
100
19
81
19
82
19
83
19
84
19
85
19
86
19
87
19
88
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
0
-100
-200
-300
-400
-500
-600
-700
3-36
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Low Savings
Savings as Percentage of Income
12
Savings as Percentage of Income
10
8
6
4
2
0
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
-2
Year
3-37
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Strong Dollars


Strong $ makes domestic products less
competitive.
High interest rate causes $ strong.
3-38
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U.S. as the Best Investment Place in the
World


High return/risk ratio
More opportunities
3-39
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Unfair Trade Practices


Are foreign countries (e.g. China, Japan) using
unfair trade practices to gain advantages in the
U.S. Market?
Will reducing trade deficits with China and Japan
help improve the U.S. trade balance?
3-40
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End Chapter Three
3-41
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